The OECD, the World Economy and China

Remarks by Angel Gurría, OECD Secretary-General, delivered at the Central Party School of the Communist Party of China (Check Upon Delivery)

Beijing, 23 March 2010

Ladies and Gentlemen:

It is a great honour to be here at the Central Party School, to share the OECD’s perspective on the recovery of the global economy, the role of China and the challenges ahead. I want to thank the Provost, Vice-Minister Zhang Boli and the Ministry of Commerce for arranging this prestigious opportunity.

For those of you who are not very familiar with the OECD, let me just mention that the OECD is an intergovernmental organisation that helps countries improve and synchronise their policies through the exchange of government experiences and mutual learning. We also help them to create innovative multilateral tools to address key global challenges. Today，as we come out of the worst crisis in our lifetimes, we are working to help countries build a stronger, cleaner and fairer world economy.

We presently have 31 member countries, which represent around 60% of the world’s GDP (in PPP terms). We are in the process of incorporating four new members (Estonia, Israel, Russia and Slovenia); we are also strengthening our cooperation with 5 key emerging Economies (Brazil, China, India, Indonesia and South Africa) through an Enhanced Engagement process, with a view to an eventual membership. Additionally, we work with around 70 other developing countries around the world.

With China, we have a longstanding history of cooperation in a wide range of policy areas, including taxation, environment, innovation, agriculture, public governance and rural and urban development, among others. Through its involvement in OECD work, China enriches the international policy debate and ensures that the decision making processes reflect its interest and policy experience.

I would like to start my presentation by sharing our view of the global economic recovery.

1. A three-speed global recovery

The recovery of the global economy is under way. After the deepest global downturn in recent history, world output is expected to grow by 4% in 2010. However, not all the engines are working at the same speed.

Growth in advanced countries will remain fragile for some time, with two different speeds, one for Europe and another one for the US and Japan. We expect average GDP to increase by 1.9% in 2010 and by 2.5% in 2011; in contrast with the far more buoyant developments and prospects in several emerging economies, like the BRICs, whose projected average growth is expected to reach 7.6% in 2010.

The crisis has left many countries with an unenviable legacy of lower potential growth, high unemployment and record deficit levels and high public debt.

We estimate that potential output has fallen by some 3% in the OECD area as a whole as a result of the crisis. This means that, because of higher unemployment and higher cost of capital our economies will produce less for quite some time.

The unemployment rate in many advanced economies rose to a high of 8.8% in December 2009 from a 25-year low of 5.6% in late 2007, leading to an increase of 16.3 million in the ranks of the unemployed.

The crisis has also wreaked havoc in public finances. Discretionary fiscal measures, coupled with cyclical revenue losses and expenditure growth, have resulted in sharp increases in budget deficits and a related build-up of government indebtedness almost everywhere in the OECD area. In fact, we project budget deficits to rise to over 8% of GDP in 2010 and government debt to exceed annual GDP by 2011.

This combination poses tremendous challenges going forward. Let me highlight two that we consider crucial for the future.

2. Fiscal consolidation and new sources of growth

Several OECD governments are confronting one of the most difficult balancing acts in the history of public policy: to find the right time and pace to withdraw their monetary and fiscal stimuli. Their fiscal balances are in deep deficits, their debts are suffocating them, but it is not clear yet if their economies can live without artificial respiration provided by public support. Quite a challenge indeed!

Many governments and central banks are preparing to take their economies off life support, and a few have already begun to remove stimulus. The pace and magnitude of fiscal consolidation will depend on individual country conditions and the state of the public finances, but one thing is clear: all governments have to publicly and clearly spell out today their longer-term consolidation strategies to reassure markets, regardless of when they start the actual implementation.

Our advice is that fiscal consolidation should be as growth-friendly as possible. Where revenue hikes are needed, emphasis should be placed on the least distortive taxes, such as on property or land, rather than on labour and income. As for spending, to the extent possible, growth-enhancing measures ─ education, training, R&D and infrastructure investment ─ should be preserved. In the context of record unemployment, governments should also emphasize labour market support policies.

To ensure long term recovery, it is essential to tap into new sources of growth, like innovation and green growth. Actually, OECD members and partner countries are working on an Innovation Strategy, which will be released in May this year, and on a Green Growth Strategy.

Our recovery cannot be based on the same polluting energies and culture of depletion of natural resources. This behaviour is leading us to a 6°C increase of average global temperatures by 2100. In other words, right to a global catastrophe. We need to transform the industrial metabolism of our economies. And this transformation can be a dynamic new source of growth.

China seems to have identified this opportunity and is reacting to this global need with anticipation, particularly in the energy efficiency field, as well as developing an ambitious plan for renewable energies, and for reducing emission intensity. We highly value these commitments and welcome it as we seek to find a political compromise in the coming COP16 climate change meeting in Mexico.

Let me now talk about how we see China in this challenging global economic context.

3. China’s impressive resilience: a base to change the growth model.

China’s economy has outperformed all expectations, both over the long haul and, more recently, during the global Great Recession. China bounced back promptly thanks to the effective monetary and fiscal stimulus. Chinese demand is helping to support the global recovery. Actually, one third of the world’s growth this year will be attributable to China’s double-digit expansion, which will ease slightly next year, as the gradual withdrawal of monetary and fiscal stimulus outweighs the impact of stronger external demand.
The strong growth performance has been accompanied by dramatic improvements in living standards. In recent years, the growth of household consumption has been amongst the most rapid in the world.

China needs to upgrade its social infrastructureAs discussed in more detail in the OECD’s 2010 Economic Survey of China, the challenge now is to sustain vigorous, balanced growth to ensure that living standards continue their rapid convergence towards those in high income countries.

The best way to do this, in our view, is to step-up public spending in social infrastructure and to unify and strengthen China’s social safety nets. This is all the more important because of income inequalities and the relatively low average levels of consumption. Higher public spending, both for central and local governments, on education, health, pensions and social assistance will reduce such inequalities and help with the transformation of the growth model. Moreover, public transfer from central government to local ones should be increased, while improving the governance of these relations.

While, like many other countries China needs to foster social cohesion, unlike many other countries, yours is in the enviable position of having the fiscal room to do it. This will also reduce the high propensity to save, thereby contributing to global rebalancing. Indeed, macroeconomic and structural policy recommendations can be mutually reinforcing.

Education, education, educationThe rapid expansion of the education system will boost productivity and help reduce income differentials over the longer run. Efforts have been deployed to ensure nine years of compulsory education and to increase education expenditures. Even so, more needs to be done to improve the quality of education, especially in rural areas and to move towards 12-years of universal school attainment. The OECD is pleased to be of help to Chinese authorities in this area, through our Programme for International Student Assessment (PISA) which this year will, for the first time, include a full-scale report of the performance of students in the Shanghai Province.

Providing greater old-age security
At the other end of the age spectrum, reducing income uncertainty for retirees will reduce the household savings rate. China’s population is ageing fast, especially in rural areas, and the elderly are increasingly unlikely to live with their descendants. A patchwork of pension arrangements exists across the country.
There are three areas of reform which can help address these challenges: (1) gradually consolidating the various pension regimes; (2) shifting more of the cost of rural pensions to the central government and pooling pension contributions nationally; and (3) raising the very low retirement ages.

Health care reformHealth outcomes in China have significantly improved due to the adoption of effective reforms with long term targets (2020). These reforms aimed at increasing investment in medical infrastructure and generalising insurance coverage, among others. However, health status still varies widely across the country, and death rates from chronic diseases are rising. Catastrophic and chronic illnesses continue to push people into poverty, especially in the poorer regions.

Reducing the economic risks of illness through better health insurance would also make for lower precautionary savings.

This calls for further policy measures focused on primary care; improved management of hospitals and better pricing in the insurance system. Once near universal coverage is achieved, including of migrants in their place of residence rather than of origin, the different insurance systems should be merged and funded more by the central government.

There is also a need for greater labour market fluidityThe new labour laws enacted in 2008 should help deal with problems such as the failure of firms to pay workers on time and the frequent lack of a formal employment contract. But here much will depend on effective enforcement. Moreover, further changes are in order. While the hukou system has been eased somewhat, it remains a major barrier to mobility and continues to split families. It also stands in the way of China’s urbanisation objectives.

In many places, migrants are or will soon be the majority of the urban labour force but without the same rights as local citizens, which may fuel social tensions. Another related problem is that if farmers do get rights in cities they lose their land use rights – a further barrier to mobility. Last, but not least, central governments should increase their transfers to local authorities.

China and the global economyFor these reforms to succeed for the benefit of China and the rest of the world, we need a positive external environment. Thus, the question of China’s exchange rate policy needs to be addressed with enormous objectivity, and I would add sobriety and statesmanship, and as part of the broader challenge of correcting the global imbalances.

The current account deficit of the United States peaked at 6% of GDP in 2006, while the current account surpluses of China, Germany and Japan in 2007 were 11, 8 and 5% of GDP respectively. While the world´s current account imbalances have moderated as a result of the recent crisis, they are set to rise again as the recovery gathers steam.

Over time, the Chinese real effective exchange rate will inevitably appreciate, as service-sector prices move towards those in the more advanced economies. The question then is how a real appreciation will occur. It can happen through domestic inflation which may portend social tensions. Alternatively, it could occur through the introduction of a more flexible exchange rate regime that would provide more independence in the conduct of monetary policy, and attenuate the looming inflationary pressures. Both for China and for the rest of the world, the latter is preferable.

This is all the more important because low growth, record unemployment and record fiscal deficits and accumulated debt in many countries, constitute the perfect breeding ground for the emergence of trade and investment protectionism. It is getting ugly out there. There are too many fingers ready to pull the trigger. We must avoid it at all cost. Any miscalculation can have disastrous consequences.

Ladies and gentlemen,
China is not alone in having to tackle domestic policy challenges of global consequences. As a major participant in the world economy, China has a stake in seeing that policy challenges in other countries are also addressed in a satisfactory manner.

The OECD’s Enhanced Engagement initiative offers opportunities for Chinese authorities to share their concerns and perspectives in a multilateral, evidence based dialogue. A closer engagement of this kind has much to contribute to global efforts to build a stronger, cleaner and fairer world economy.